Schuyt v. Rowe Price Prime Reserve Fund, Inc.

• Decision Date: 01 July 1987
• Docket Number: No. 80 Civ. 506 (RJW).,80 Civ. 506 (RJW).
• Citation: 663 F. Supp. 962
• Parties: Gertrude Brooks SCHUYT, Plaintiff, v. ROWE PRICE PRIME RESERVE FUND, INC., T. Rowe Price Associates, Inc., Carter O. Hoffman, Edward A. Taber III and George J. Collins, Defendants.
• Court: U.S. District Court — Southern District of New York

663 F. Supp. 962

Gertrude Brooks SCHUYT, Plaintiff, v. ROWE PRICE PRIME RESERVE FUND, INC., T. Rowe Price Associates, Inc., Carter O. Hoffman, Edward A. Taber III and George J. Collins, Defendants.

No. 80 Civ. 506 (RJW).

United States District Court, S.D. New York.

July 1, 1987.

Wolf Haldenstein Adler Freeman & Herz, New York City (Daniel W. Krasner, Jeffrey G. Smith, Sindy R. Udell, of counsel), Stull, Stull & Brody, New York City (Robert Stull, of counsel), for plaintiff.

Shereff Friedman Hoffman & Goodman, New York City, for defendant Rowe Price Prime Reserve Fund, Inc.; Jerome Marshak, Robert D. Helfand, of counsel.

Pollack & Kaminsky, New York City, for defendants T. Rowe Price Associates, Inc. Carter O. Hoffman, Edward A. Taber III, and George J. Collins; Daniel A. Pollack, Martin I. Kaminsky and Henry H. Hopkins, of counsel.

OPINION

ROBERT J. WARD, District Judge.

This matter is before the Court for a decision on the merits following a two-week bench trial. Plaintiff, a shareholder in the Rowe Price Prime Reserve Fund, Inc. ("Prime Reserve Fund" or the "Fund") brought this action pursuant to the Investment Company Act of 1940, as amended, 15 U.S.C. § 80a-1 et seq. ("ICA"), asserting three claims for relief. Count I, asserted against defendants T. Rowe Price Associates, Inc. ("Price Associates" or the "Adviser"), raises a claim for excessive fees under section 36(b) of the ICA. 15 U.S.C. § 80a-35(b). Count II, brought against all defendants, is based on diversity of citizenship and alleges breach of fiduciary duty under state law. Count III, also asserted against all defendants, alleges violations of section 20(a) of the ICA, 15 U.S.C. § 80a-20, and Rule 20a-1 promulgated thereunder, 17 C.F.R. § 270.20a-1, in connection with a proxy statement disseminated to Fund shareholders to solicit their approval of a proposed investment advisory agreement for 1980 and 1981.¹

After consideration of the testimony presented at trial, the evidence and exhibits introduced, the proposed findings of fact and conclusions of law of the parties, and the applicable law, the Court makes the following findings of fact and conclusions of law pursuant to Rule 52, Fed.R.Civ.P.²

BACKGROUND

Plaintiff Gertrude Brooks Schuyt, a resident of the State of New York, became a shareholder of defendant Prime Reserve Fund on April 24, 1979 and has remained a shareholder at all relevant times. Defendant Prime Reserve Fund, a Maryland corporation, is an open-end, diversified management investment company registered under the ICA. The Fund, which continuously offers its shares of stock to the public,³ invests in prime money market instruments and is commonly known as a "money market fund."⁴ During the relevant time period in this litigation, the fund grew in size from about $200 million in net assets to about $2 billion in net assets.⁵ During this time, the fees paid by the Fund to the investment adviser, which were based on a set percentage of the Fund's net assets, correspondingly increased from $1,734,755 in 1979, to $4,331,360 in 1980, and to $8,362,250 in 1981.

Defendant Price Associates, also a Maryland corporation,⁶ served during this time as the investment adviser to Prime Reserve Fund pursuant to Investment Advisory Agreements ("Agreement") between the Adviser and the Fund.⁷ Defendant Carter O. Hoffman ("Hoffman") was a director and Chairman of the Board of Prime Reserve Fund and the Senior Vice President, a shareholder, and a director of Price Associates. Defendant Edward A. Taber ("Taber") was a director and President of Prime Reserve Fund. Taber also served as Chairman of the Advisory Committee of Prime Reserve Fund⁸ and was a Vice President and a shareholder of Price Associates. Defendant George J. Collins ("Collins"), presently the President and Chief Executive Officer of Price Associates, was the Vice President, a shareholder, a director, and head of the Fixed Income Division of Price Associates during the time at issue in this litigation. He was also a director and Vice President of Prime Reserve Fund.

The composition of the Board of Directors of Prime Reserve Fund changed during the time period from the approval of the 1979 Agreement to the approval of the 1981 Agreement. On February 15, 1979, the date the 1979 Agreement was approved, the Board of Directors of the Fund consisted of three inside or interested directors, Hoffman, Taber, and Collins, and two outside or independent directors, Hubert P. Vos ("Vos") and Lawrence P. Naylor, III ("Naylor").⁹ On February 27, 1980, the date the 1980 Agreement was approved, the directors of the Fund were Hoffman, Taber, Collins, Vos, and Anthony W. Deering ("Deering"). Deering had become an outside director in April 1979, replacing Naylor who had resigned. On February 25, 1981, the date the 1981 Agreement was approved, the directors of the Fund were Hoffman, Taber, Collins, Vos, Deering, and two new outside directors, Dr. Karen N. Horn ("Horn") and F. Pierce Linaweaver ("Linaweaver").

During all relevant times, the independent directors of Prime Reserve Fund had their own counsel, Stanley J. Friedman ("Friedman"), a partner in the law firm of Shereff, Friedman, Hoffman & Goodman. Friedman had been counsel to Prime Reserve Fund since the Fund was organized in 1975. During 1979 through 1981, Friedman spoke weekly or biweekly with the outside directors. In addition, he furnished the directors with detailed written and oral advice regarding their duties, including their responsibilities in evaluating the Agreements between the Adviser and the Fund. Friedman apprised them, on a continuing basis, of pertinent legal developments relating to mutual funds, including their responsibilities under section 36(b) of the ICA.¹⁰

The Fixed Income Division of Price Associates was responsible for the credit and investment analysis for the nonequity mutual funds managed by the Adviser, including Prime Reserve Fund. This Division was directed by Collins, with Taber as Assistant Director. Both had extensive experience in the fixed income securities business. Approximately 24-26 individuals worked in the Fixed Income Division. With regard to the Fund, the specific function of the Fixed Income Division was to provide research and analysis at the weekly meeting of the Investment Advisory Committee.¹¹ The directors of the Fund received periodic reports on the functioning and work of the Fixed Income Division.¹²

History of the Prime Reserve Fund

The Prime Reserve Fund was organized on October 31, 1975. Price Associates was retained as the Fund's investment adviser pursuant to an Investment Advisory Agreement between the Fund and the adviser dated January 28, 1976. In the early years of the Fund's existence, the Adviser absorbed all of the Fund's operating expenses and in 1976 voluntarily waived payment of the management fee in order to help the Fund maintain a competitive yield in the industry. As of December 31, 1976, the Fund had 590 shareholder accounts to service, with the account size averaging $86,000. From 1976 through the beginning of 1979, the Fund grew at a moderate pace.¹³ During this time, the Fund operated at a loss for the Adviser. However, by the end of 1979, yield rose to unprecedented levels and the Fund grew enormously.¹⁴ By December 31, 1979, the Fund had 57,343 shareholder accounts to service, with the account size averaging $12,494. Throughout this time, the Investment Advisory Agreement, which was extended for a year at the February 15, 1979 Board meeting, provided for a fee to the Adviser of .4% of the Fund's average daily net assets.

Plaintiff Becomes a Shareholder

On April 24, 1979, plaintiff became a shareholder of Prime Reserve Fund. At this time, the net assets of the Fund were approximately $300 million. Plaintiff conceded in her deposition that she believed the fee of .4% was fair and reasonable throughout 1979. Indeed, many comparable money market funds were charged .5% in 1979.

The independent directors of the Fund met privately with their attorney Friedman on October 30, 1979, at Cross Keys Inn in Maryland to discuss the status of the Fund, its recent growth, and its expenses, including marketing expenses. As noted above, the sudden and historically unprecedented rise in interest rates during late 1979 and early 1980 led to an astonishing rate of growth for the Fund. This extraordinary growth in asset levels, reaching approximately $700 million by the end of 1979, had not been anticipated by the directors or the Adviser.

At this point in time, the directors and the Adviser became increasingly concerned about the volatility and the growth of the fund. With regard to volatility, they feared that fluctuations in interest rates and inflation might cause a sudden change in the level of the Fund's net assets. With regard to growth, they believed that it was in the best interest of the Fund to increase as much as possible as such growth would permit the Fund to invest in larger, better quality instruments and would enhance the Fund's reputation.

Renewal Process for 1980 Investment Advisory Agreement

In light of the significant growth of the Fund during the fall and winter of 1979, Calhoun, Vice President of Price Associates, suggested to the Executive Committee of Price Associates on January 4, 1980 that the Adviser recommend a reduction in its advisory fee to the Fund from the .4% to .35% when the net asset level reached $1 billion. On January 7, 1980, the Executive Committee discussed and approved the fee break recommendation. The Board of Directors of Price Associates, on January 10, 1980, also approved the fee break proposal.

On January 15, 1980, Friedman sent to the directors of the Prime Reserve Fund his annual memorandum on the factors they should consider in evaluating the Investment Advisory Agreement. Friedman advised that the directors should consider the following:

1. The requirements of the Fund in the areas of investment supervisory and

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